Olstein All Cap Value Fund 2nd Quarter Letter to Shareholders

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- By Holly LaFon

Dear Fellow Shareholders:


For the fiscal year ended June 30, 2016, Class C shares of the Olstein All Cap Value Fund depreciated 8.83%. During the same twelve-month period, the Russell 3000(R) Value Index appreciated 2.42% and the Russell 3000(R) Index appreciated 2.14%. For the three-year period ended June 30, 2016, Class C shares of the Olstein All Cap Value Fund had an average annual return of 6.64% compared to an average annual return of 9.58% for the Russell 3000 Value Index.



Market Outlook


Throughout the twelve-month reporting period ended June 30, 2016, lethargic economic growth continued to depress equity markets while specific events, including the United Kingdom's vote to exit the European Union, sharply increased market volatility and contributed to growing uncertainty about future economic growth. Yet despite hitting a low on February 11, 2016, U.S. equity markets have rebounded strongly and have continued to perform positively after the close of the Fund's fiscal year. In fact, the Russell 3000 Index has rebounded approximately 21% from its February 11, 2016 low to close at an all-time high on July 29, 2016 (similarly, Class C shares of the Olstein All Cap Value Fund also appreciated approximately 21% over the same period).


Notwithstanding the increase in market volatility and uncertainty regarding global growth, we maintain a cautiously optimistic outlook for value equity investing for the remainder of 2016. While there are always forecasters predicting the next market correction, as value investors we believe it is important to weather negative economic and market events by taking advantage of periods of short-term volatility to purchase equities of financially strong companies with stable or growing free cash flow, run by managements that have a demonstrated history of deploying cash to the benefit of shareholders, and selling at a material discount to our calculation of private market value. At the current time, we believe there is a strong case for investing in the equity securities of free cash flow companies whose real economic value is unrecognized by the market, obscured by recent market uncertainty or over- shadowed by temporary problems.


Our Strategy


There are times when the combination of certain events, such as the recent Brexit vote, the slowdown in the Chinese economy, falling commodities prices, and the uncertainty that accompanies a general election, tend to overwhelm equity markets and hit a value-oriented portfolio such as the Fund's, causing a period of short-term underperformance. At the same time, however, from our perspective as long-term value investors, the negative reaction during periods of increased market volatility often creates favorable opportunities for the Fund to buy good companies at bargain prices which despite the short-term underperformance, in our opinion, can increase the probability of long-term outperformance.


Throughout the Fund's history, Wall Street's obsessive focus on short-term events has often produced significant opportunities for the Fund to profit from pessimism as deviations between stock prices and company valuations increase dramatically. We believe we are currently in one of those periods with many investors reacting to negative news with little regard for company fundamentals. Industrials, regional banks and retailers have been particularly punished whereas most of the Internet-related growth stocks are selling at prices that assume perfection forever. During such periods, we believe we can find viable investment opportunities by focusing on four primary, company-specific factors: (1) a commitment to maintain a strong financial position as evidenced by a solid balance sheet; (2) an ability to generate sustainable free cash flow; (3) management that intelligently deploys cash balances and free cash flow from operations to increase returns to shareholders; and (4) selling at a material discount to our calculation of private market value as a result of negative factors that we believe are temporary.


We continue to seek and invest in companies that we believe have an ability to deliver long-term value to their shareholders which, in our opinion, is not being properly valued by the market. For the remainder of this year, and in light of concerns about the level of economic growth, we intend to remain focused on individual companies, their operations, and their prospects for maintaining or growing sustainable free cash flow. We further believe that by prioritizing these factors, our portfolio should be positioned to compete more profitably as economic growth improves.


Portfolio Review


Our current portfolio consists of companies that we believe have a sustain- able competitive advantage, discernible balance sheet strength, a manage- ment team that emphasizes decisions based on cost of capital calculations and deploys free cash flow to create shareholder value. We believe companies with these characteristics are poised to eliminate the valuation gaps cre-ated by the recent events as economic growth accelerates.


At June 30, 2016, the Olstein All Cap Value Fund portfolio consisted of 87 holdings with an average weighted market capitalization of $58.12 billion. During the fiscal year, the Fund initiated positions in fifteen companies and strategically added to positions in fifteen companies. Over the same time period, the Fund eliminated its holdings in thirty-one companies and strategically decreased its holdings in another twenty-three companies.


Positions initiated during the last twelve months include: American Express Company, Baker Hughes, Inc., Charles River Laboratories, Coach Inc., Express Scripts Holding Company, FedEx Corp., Hologic Inc., IPG Photonics Corp., Kennmetal Inc., Michael Kors Holdings, Procter & Gamble, Scripps Network Interactive, SeaWorld Entertainment, Inc., The Walt Disney Company, and Zebra Technologies Corp.


Positions eliminated during the past twelve months include: Abbott Laboratories, ABM Industries, ADT Corp., Alaska Air Group, Chubb Corp., Dorman Products, Dover Corp., Entegris Inc., Equifax Inc., Esterline Technologies, Express Inc., Exxon Mobil, First Niagara Financial Group, Fossil Group, HCA Inc., Itron Inc., Johnson Controls, Inc., Joy Global, Inc., Masco Corp., MSC Industrial Direct Co., National Oilwell Varco, NVIDIA Corporation, Qualcomm Incorporated, Ralph Lauren Corp., Sealed Air Corp., Smith & Wesson Holding Corp., TE Connectivity, Teradata Corp., Towers Watson & Co., UniFirst Corporation, and VASCO Data Security International, Inc. It is important to note that the Fund eliminated its positions in Towers Watson, Chubb Corp., and First Niagara Financial Group on favorable terms as these companies were targeted by strategic partners or acquirers during the reporting period.


Our Leaders

The stocks which contributed positively to performance for the twelve-month reporting period include: Michael Kors Holdings Ltd. (KORS), Intuitive Surgical, Inc. (ISRG), Coach Inc. (COH), DuPont, and Brady Corporation (BRC). At the close of the fiscal year, the Fund continued to maintain positions in Michael Kors Holdings, Intuitive Surgical, Coach Inc., and Brady Corporation. The Fund liquidated its position in DuPont during the latter half of 2015. Although DuPont is an out- standing company, the price of its stock had reached a level where we believed it was more prudent to pursue other opportunities that we believed offered more compelling discounts to our calculation of private market value.


Our Laggards


Laggards during the twelve-month reporting period include: Joy Global, Inc. (JOY), Fossil Group (FOSL), Esterline Technologies Corp. (ESL), Dillard's Inc. (DDS), and Legg Mason, Inc. At the close of the fiscal year, the Fund maintained positions in Dillard's Inc. and Legg Mason. During the fiscal year, the Fund liquidated its positions in Joy Global, Fossil Group and Esterline Technologies. We liqui- dated the Fund's position in Joy Global as we misjudged the severity of the downturn in the mining business and the extent of pressure the downturn put on the company's operations. We also liquidated the Fund's holdings in Fossil Group, the global luxury timepiece and accessories supplier, as we underestimated the shift in consumer taste and preference towards smart watches. We liquidated holdings in Esterline Technologies due to the company management's inability to execute on its integration and turnaround strategy within our required time frame.


Considering Risk and Staying the Course in Turbulent Times


As we have discussed in many of our previous letters, we believe that the key to achieving above-average long-term performance is rooted in an ability to limit or avoid material errors. In other words, to achieve long-term success, we believe the Fund must first consider downside risk before considering the potential for appreciation. We further believe that our emphasis on assessing downside risk before determining upside potential is extremely critical in today's environment characterized by market volatility and tepid economic growth. As many investors react to the day-to-day gyrations of the overall market by reducing or selling their equity positions, we are reminded of the importance of maintaining a proper long-term perspective when investing in equities. No recent market news or event drives this point home more clear- ly than the recent Brexit vote and the short-term negative market reaction that followed and then corrected within a matter of days.


Towards the end of the Fund's fiscal year, on June 23, 2016, citizens throughout the United Kingdom voted to determine if they should remain a member of or leave the European Union. While the Brexit vote was indeed a remarkable political event with significant implications for the European and global economic outlook, it also provided a valuable lesson on market psychology and investor behavior. In the weeks leading up to the Brexit vote, equity markets were increasingly volatile; falling and rallying on polling data and speculation about the expected outcome of the vote. Yet despite all the daily gyrations in the market from June 1, 2016 to the close of the market on the day of the vote, the benchmark Russell 3000 Index actually rose 1.01%. When news broke that the United Kingdom had indeed voted to leave the European Union, equity markets caught off-guard by the unexpected result plummeted with the Russell 3000 Index dropping 5.59% over the two trading days following the vote. Yet, roughly one month after the vote and the severe market reaction to the eventual withdrawal vote, U.S. equity markets had overcome their overwhelmingly negative sentiment with the Russell 3000 Index reaching an all-time high on July 29, 2016.


We recount the timeline of, and market reaction to, the Brexit vote to highlight important elements of our value-oriented investment process - staying patient, calm, and balanced when faced with a turbulent market, and staying focused on long-term business fundamentals and a company's long-term normalized ability to generate future free cash flow. By staying calm and not reacting rashly to unfavorable short-term news, we believe we avoided making the mistakes many investors may have made during the turbulent Brexit period. When all was said and done regarding the Brexit vote event, between June 1, 2016 and July 31, 2016, a short two-month period characterized by excessive day-to-day market volatility, the Russell 3000 Index actually rose 4.18%. Investors who reacted at the first hint of bad news were likely to miss these returns and may have ultimately impaired their capital base.


While we do not minimize the potential worst-case impact certain events such as the Brexit vote may have on equity markets, we believe it is important to distinguish between the variability of an investment's value due to temporary market volatility, and the likelihood of permanent impairment of an investor's capital. For a value investor, short-term market volatility is less of a concern than the irreversible loss of capital due to the erosion of a company's business fundamentals over time. Another costly mistake would be a poorly timed decision to sell a particular holding that is declining in response to investor panic during a period of short-term market meltdown whose long-term value has not been impaired. Business values do not fluctuate as rapidly as stock prices, and it is important that the Fund take advantage of a stock's deviations from our calculation of private market values if we hope to achieve the Fund's primary objective of long-term capital appreciation. It is frustrating to underperform during these periods of investor short-term negative psychology created by overreaction to events. However, our eyes stay fixed on long-term absolute returns for our shareholders by focusing on our long-term private market values based on business fundamentals and the analysis of normalized future free cash flows. Although it is a tempting objective to predict stock market movements, we have yet to witness an investor who can time markets over long periods of time.


To a certain degree, investor apprehension and concerns about equity markets are understandable when considering the media's breathless coverage of economic events, business policy, stock market predictions, political events and quarterly earnings beats and misses. Whether it is the economic slowdown in China, the expected negative impact of a strengthening U.S. dollar on corporate earnings, or the negative impact of the Brexit vote on the future of the European Union, crises and calamities have intermittently dominated headlines and shaken investor confidence.


In our experience, pessimism about the direction of the overall market often leads investors to two potential mistakes: it motivates poorly timed asset allocation or sell decisions (that may impair the investor's capital) and/or it blinds an investor to the future appreciation potential of companies with a sustainable competitive advantage, discernible balance sheet strength, and management teams that can effectively adjust to challenging times to create meaningful long-term shareholder value. Companies with the aforementioned characteristics are not only poised to overcome temporary valuation gaps created by market volatility in reaction to negative short-term events but are also usually in a position to achieve greater capital appreciation as market conditions improve and economic activity accelerates. While we believe investors are wise to be wary of risk, instead of making investment decisions based on market sentiment, the Fund should focus on opportunities for meaningful capital appreciation presented by individual companies on the basis of favorable long-term fundamentals and the ability to generate long-term sustainable free cash flow that we believe is not being properly valued by the market.


From our perspective as value investors, recent market volatility has produced an environment in which there are many individual opportunities that offer investors the potential for above-average capital appreciation. Our quest for value is guided by two prerequisites: (1) a company's ability to gen-erate sustainable future free cash flow; and (2) securities prices that allow us to buy good companies, with solid balance sheets, and profitable business models, at very advantageous prices. These two requirements guide our investment process and force us to focus on a company's future prospects and value while capitalizing on current favorable prices. We never know the exact timing of when markets change the focus from short-term events to long-term fundamentals. However, we do expect eventual change and stock appreciation to occur within a 12-to 24-month period.


Uncertainty and volatility are common adversaries when determining the future value of a company, even under normal market conditions. However, when market downturns or periods of volatility hit equity markets across the board, the stocks of many good companies are penalized by negative market sentiment or reduced expectations that have little to do with a company's underlying financial performance. A company may have the misfortune of being in a sector that has fallen out of favor or may sell to an industry that is expected to underperform. A portion of a company's business may originate from a country or region suffering from a pullback in economic activity or a company may have exposure to an unfavorable economic trend such as falling commodities prices. Whatever the reason, investors often feed off of and/or overreact to broad negative market sentiment by selling a broad range of com-panies without regard for an individual company's business fundamentals, without considering how well an individual company may weather such adversity or if the current stock price already discounts the potential negatives.


For value investors, this often short-sighted market dynamic creates ample opportunities to buy great companies at substantial discounts which, in turn, sow the seeds for future potential outperformance. Unfortunately sentiment is usually slow to turn, but many times in the past, periods of underperformance have preceded material gains for the Fund. For us, the most important metric for identifying superior investment opportunities in an uncertain market is a company's ability to generate sustainable free cash flow. We look to invest in companies with strong balance sheets that have not only the financial strength to weather periods of economic uncertainty, but have managements who have demonstrated an ability to allocate capital wisely during such challenging periods. Because we are so focused on a company's ability to generate free cash flow during both favorable and unfavorable economic cycles, we often identify investment opportunities initially overlooked by the market or disregarded by investors (too concerned with stock price volatility, short-term events and the pessimism dominating the "here and now").

A basic tenet of the Fund's investment philosophy states that "a company's free cash flow is the primary determinant of its value as an ongoing enterprise". Thus when the Fund determines that an individual company is reacting favorably to a challenging economic environment by continuing to generate a material level of sustainable free cash flow (that should lead to a competitive advantage and is not being properly valued by the market), the Fund purchases the stock for its portfolio (concluding the company will eventually draw the favorable attention of equity investors as markets gain a more balanced perspective).

Before any company is purchased for the portfolio, the Fund's investment process focuses on analyzing the business fundamentals of each company based on looking behind the numbers of financial statements on a company by company basis and pays little attention to overall market sentiment. The analysis focuses on the cash return the Fund can expect from owning a share of a business over the next three- to five years, and whether or not the expected return compensates the Fund (in excess of the risk free rate of return) for the risk of investing in equities and correctly predicting future sustainable future free cash flow, which eventually determines the value of a company. To us, this last question holds greater importance at a time when nervous investors are being told to be wary of equities. We believe such times have the potential to set up significant above-average long-term investment returns for the Fund.

Final Thoughts

We believe that our methodology, which seeks to avoid long-term impairment of capital by valuing companies based on an exhaustive analysis of financial statements to determine sustainable future free cash flow, provides shareholders with the potential to realize above-average long-term returns. As we saw in the aftermath of the Brexit vote, short-term price movements and tempo- rary declines in stock prices do not necessarily cause long-term investors to lose money. As previously stated, business values do not change as often or as rapidly as stock prices. The chances of downside fluctuations are present in all securities. Spending time analyzing these monthly swings or attempting to minimize these swings by giving up potential positive future long-term returns based on an analysis of business fundamentals and potential future free cash flow is, in our opinion, a poor use of time and capital. Sustainable future free cash flow is the eventual arbiter of stock prices. It is our opinion that short-term price fluctuations have little to do with the measurement of risk or long- term business values if one's investment horizon is three years or more. The Fund's investment horizon is 3 to 5 years.


In conclusion, the Fund focuses on understanding a business, its potential to generate future sustainable free cash flow and ultimately its value. After identifying companies that meet well-defined investment criteria, we then take advantage of market volatility and downward price movements to buy such companies at advantageous prices that we believe increase the chances of a successful investment. We also believe that paying the right price is the best protection when seeking to limit losses.


We value your trust and remind you that our money is invested alongside yours as we work hard to accomplish the Fund's objective of long-term capital appreciation. We look forward to writing to you again at the close of the next quarter.


Sincerely,

Robert A. Olstein

Chairman, Chief Investment Officer and Co-Portfolio Manager


Eric R. Heyman

Co-Portfolio Manager





Details



The performance data quoted represents past performance and does not guarantee future results. The Olstein All Cap Value Fund's Class C average annual return for the one-year, five-year, and ten-year periods ended 6/30/16, assuming reinvestment of dividends and capital gain distributions and deduction of the Olstein All Cap Value Fund's maximum CDSC of 1% during the one-year period, was -9.61%, 8.73%, and 4.52%, respectively. Per the Fund's prospectus dated 10/31/15, the expense ratio for the Olstein All Cap Value Fund Class C was 2.27%. Performance and expense ratios for other share classes will vary due to differences in sales charge structure and class expenses. The investment return and principal value of an investment will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than performance quoted. To obtain performance data current to the most recent month end, please go to our website at www. olsteinfunds.com.


The above represents opinion, and is not intended to be a forecast of future events, a guarantee of future results, or investment advice. The references to securities are not buy or sell recommendations, but are intended to be descriptive examples of the fund's investment philosophy and are subject to change. Do not make investments based on the securities referenced. As of 6/30/16, the Olstein All Cap Value Fund maintained a position in the following securities referenced and is subject to change: American Express Co. (0.9%); Baker Hughes Inc. (0.2%); Charles River Laboratories (0.5%); Coach Inc. (0.3%); Express Scripts Holding Co. (1.3%); FedEx Corp. (0.3%); Hologic Inc. (0.8%); IPG Photonics Corp. (0.6%); Kennmetal Inc. (0.4%); Michael Kors Holdings (0.9%); Procter & Gamble Co. (0.5%); Scripps Network Interactive (0.8%); SeaWorld Entertainment, Inc. (0.4%); The Walt Disney Co. (1.0%); Zebra Technologies Corp.(1.4%); Intuitive Surgical Inc. (0.7%); Brady Corp. (0.4%); Dillards Inc. (1.2%); and Legg Mason Inc. (1.4%). As of 6/30/2016, the Olstein All Cap Value Fund did not maintain a position in the following securities mentioned and is subject to change: Abbott Laboratories; ABM Industries; ADT Corp.; Alaska Air Group; Chubb Corp.; Dorman Products; Dover Corp.; DuPont (E.I.) De Nemours; Entegris Inc.; Equifax Inc.; Esterline Technologies; Express Inc.; Exxon Mobil; First Niagara Financial Group; Fossil Group; HCA Inc.; Itron Inc.; Johnson Controls, Inc.; Joy Global, Inc.; Masco Corp.; MSC Industrial Direct Co.; National Oilwell Varco; NVIDIA Corporation; Qualcomm Incorporated; Ralph Lauren Corp.; Sealed Air Corp.; Smith & Wesson Holding Corp.; TE Connectivity; Teradata Corp.; Towers Watson & Co.; UniFirst Corporation and VASCO Data Security International, Inc. This information should be preceded or accompanied by a current prospectus, which contains more complete information, including investment objectives, risks, charges and expenses of the Olstein Funds and should be read carefully before investing. A current prospectus may be obtained by calling (800) 799-2113 or visiting the Olstein Funds' website at www.olsteinfunds.com.


The Olstein Funds follow a value-oriented investment approach. However, a particular value stock may not increase in price as the Investment Manager anticipates and may actually decline in price if other investors fail to recognize the stock's value or if a catalyst that the Investment Manager believes will increase the price of the stock does not occur or does not affect the price of the stock in the manner or to the degree that the Investment Manager anticipated. Also, the Investment Manager's calculation of a stock's private market value involves estimates of future cash flow which may prove to be incorrect and, therefore, could result in sales of the stock at prices lower than the Fund's original purchase price. There is no assurance that the fund will achieve its investment objective.

This article first appeared on GuruFocus.


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